Tightening the screws on debt dwellers

By Brian Fallow

Between the lines

Among all the uncertainties the Reserve Bank has to grapple with in setting monetary policy, few are more slippery than the effects of the massive increase in household debt in the 1990s.

It affects decisions about how much need there is for a tightening policy, how much impact a given rise in interest rates will have, and when tightening needs to begin.

Since the early 1990s household debt, mainly mortgages, has risen from about 60 per cent of disposable incomes to close to 100 per cent. It is still rising apace.

At June 30 New Zealand had borrowed $54.5 billion on mortgages, 10 per cent higher than a year earlier and up more than a third on three years ago.

Despite that, one of the key assumptions in the bank's latest economic forecasts is that households' appetite for additional debt is nearly sated.

If it changes its mind about that and begins to see signs of a repeat of the debt-propelled housing boom of the early to mid-90s, the outlook for interest rates could get ugly.

At the moment, though, forecasters are picking rates to peak at about 2 or 2.5 per cent above current levels in two or three years' time. That implies mortgage rates of about 9 per cent, well below the rates hit during the last cycle.

One of the reasons economists are expecting the coming tightening phase to be slower and gentler than last time is that they see households as more sensitive to interest rate rises, because they are carrying more debt.

Deutsche Bank chief economist Ulf Schoefisch is not so sure, however.

He points to the fact that about 60 per cent of mortgages are on fixed rates, with an average of just over two years to run. Even with floating rate mortgages it is common for banks to allow a borrower, when rates rise, to push out the term of the loan rather than increase repayments.

Those two factors should weaken and delay the impact on household finances of any moves to raise interest rates. Though debt is rising, so are incomes, and with lower interest rates debt servicing costs will remain significantly below their 1998 peak, Mr Schoefisch says.

The Reserve Bank said on Wednesday that with 40 per cent of mortgages floating and another 20 per cent in fixed rates coming up for repricing, a policy tightening would still have a "fairly rapid" impact in the mortgage market. On balance though, it said, the higher proportion of fixed loans would mean the impact of rising short-term rates on households' spending power would be somewhat more drawn-out than it used to be.

That may be one reason it has flagged an earlier-than-expected start to the tightening.